John R. Swinton, Ph.D. Center for Economic Education Georgia College & State University

 Question: ◦ Suppose that roses are produced in a perfectly competitive, increasing-cost industry in long-run equilibrium with identical firms.  Draw correctly labeled side-by-side graphs for the rose industry and a typical firm and show each of the following:  Industry equilibrium price and quantity, labeled Pm and Qm, respectively.  The firm’s equilibrium price and quantity, label Pf and Qf, repectively.

 Assumptions: ◦ Price Takers (buyers AND sellers) ◦ Large Number of Sellers and Buyers ◦ No Barriers to Entry ◦ Identical Products ◦ Complete Information ◦ Profit-maximizing Behavior

 Individual Firm Decision: ◦ Rule #1: Set Output such that MC=MR  MR = Market Price (because the firm is a price taker) ◦ IF MR < min AVC then Shut Down! ◦ IF MR > min AVC but < min ATC then Stay Open in the short run and Shut Down in the long run ◦ IF MR ≥ Min ATC then Stay Open

 Graphically: Quantity good X Price good X 0 MC ATC Min ATC

 Graphically: Quantity good X Price good X 0 Supply ATC Min ATC Produce Shut Down MC

 Meanwhile, the Market: Quantity Roses Price Roses Demand (or MB) 0 Supply (or MC) Qm Pm

 Meanwhile, the Market: Quantity Roses Price Roses Demand (or MB) 0 Supply (or MC) Qm Pm

 Graphically: Quantity Roses Price Roses 0 ATC Min ATC Qf MC Pm=Pf=MR

 Assume there is an increase in demand for Roses. Quantity Roses Price Roses Demand (or MB) 0 Supply (or MC) Qm Pm New Demand (or MB) New Qm New Pm

 Short-run reaction: Quantity Roses Price Roses 0 ATC Qf MC Pm=Pf=MR New Pm=Pf New Qf

 Short-run reaction: Quantity Roses Price Roses 0 ATC MC New Pm=Pf New Qf Profits

 Long-run: ◦ Profits attract entry of identical firms. Quantity Roses Price Roses 0 Supply (or MC) Pm New Demand (or MB) New Qm New Pm New Long-run Qm Entry

 Long-run reaction: ◦ As firms enter the price returns to its original level Quantity Roses Price Roses 0 ATC Original Qf MC Original Pm=Pf=MR New Pm=Pf New Qf

 Results: ◦ Number of firms will increase – because they were attracted by the profits created by the increase in demand. ◦ Each firm’s ATC will remain exactly where it was before – nothing in the question impacts the cost of production. ◦ Profit maximizing price will be exactly as it was in the original part – the firms that entered were exactly the same as the ones that were already in the industry so their ATC look the same. ◦ Profits will be zero once again.